Sohu.com (SOHU) Reports Third Quarter 2010 Unaudited Financial Results

BEIJING — Sohu.com Inc. (Nasdaq: SOHU), China’s leading online media, communications, search, online games and wireless value-added services group, today reported unaudited financial results for the third quarter ended September 30, 2010.

Third Quarter 2010 Highlights (1)

• Record high total revenues and record high revenues for brand advertising, search and online games. All such operating parameters exceeded high end of Group guidance.
• Total revenues were US$164.1 million, up 20% year-on-year, and 12% quarter-over-quarter.
• Brand advertising revenues were US$59.1 million, up 22% year-over-year and 11% quarter-over-quarter.
• Search revenues reached US$5.4 million, up 134% year-over-year and 38% quarter-over-quarter.
• Online game revenues reached US$85.6 million, up 25% year-over-year and 10% quarter-over-quarter.
• Before deducting the share of net income pertaining to the Non-Controlling Interest, GAAP net income for the third quarter of 2010 was US$54.0 million, up 15% year-over-year and 19% quarter-over-quarter. Non-GAAP net income was US$61.3 million, up 19 % year-over-year and up 17% quarter-over-quarter, exceeding high end of Group guidance.
• After deducting the share of net income pertaining to the Non-Controlling Interest, GAAP net income was US$38.7 million, up 12%  year-over-year and 24% quarter-over-quarter,  or US$1.01 per fully diluted share, and non-GAAP net income was US$45.2 million, up 21% year-over-year and quarter-over-quarter, or US$ 1.16 per fully diluted share, exceeding high end of Group guidance.

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Dr. Charles Zhang, Chairman and CEO of Sohu.com, commented, “I’m pleased to report that we had a record quarter, with strong growth in each of our major business segments.  Online video, our potential future revenue driver, is gaining significant traction as we add high-definition content and leverage the synergies of the Sohu platform to make our video products even more attractive to both users and advertisers. Also we believed that the introduction of strategic investors to our Sogou search business leaves our search business in a more competitive position and offers great promise for future collaboration and services with China’s largest e-commerce website.”

“Our largest business segment, online games, powered by the successful release of new expansion packs for our proprietary flagship product and the launch of new licensed games, once again achieved solid results. The results also demonstrated the merits of using feedback to direct research and development efforts in our games. We continue to invest in employee recruitment and training. We are positive on the outlook of the industry and look to bring more proprietary games to market with an expanded team of talented engineers.”

Commenting on Sohu’s brand advertising business, Ms. Belinda Wang, Co-President and COO, said, “Our brand advertising business also set new records in the third quarter. Our expanding group of advertising partners is taking advantage of strong economic conditions in China along with particular strength in each of their end markets.  More specifically, they are looking to us to help maximize their advertising spending based on our significant investments in our online platform and other value-added solutions.

Third Quarter Financial Results

Revenues

Total revenues for the third quarter ended September 30, 2010 were US$164.1 million, up 20% year-over-year and 12% quarter-over-quarter.

Brand advertising revenues for the third quarter of 2010 totaled a record high of US$59.1 million, up 22% year-over-year and 11% quarter-over-quarter.

Search revenues for the third quarter of 2010 were US$5.4 million, up 134% year-over-year and 38% quarter-over-quarter.

Online game revenues for the third quarter of 2010 were US$85.6 million, up 25% year-over-year and 10% quarter-over-quarter.

Wireless revenues for the third quarter of 2010 were US$13.6 million, down 19% year-over-year and up 23% quarter-over-quarter.

Gross Margin

Gross margin was 74% for the third quarter of 2010, compared with 73% in the second quarter of 2010 and 76% in the third quarter of 2009. Non-GAAP gross margin for the third quarter of 2010 was 74%, compared with 74% in the second quarter of 2010 and 76% in the third quarter of 2009.

Brand advertising gross margin for the third quarter of 2010 was 61%, compared with 58% in the second quarter of 2010 and 68% in the third quarter of 2009. Non-GAAP brand advertising gross margin for the third quarter of 2010 was 62 %, compared with 60% in the second quarter of 2010 and 69% in the third quarter of 2009.

Online game gross margin for the third quarter of 2010 was 90%, compared with 91% in the second quarter of 2010 and 93% in the third quarter of 2009. Non-GAAP online game gross margin for the third quarter of 2010 was 90%, compared with 91% in the second quarter of 2010 and 93% in the third quarter of 2009.

Wireless gross margin for the third quarter of 2010 was 46%, compared with 48% in the second quarter of 2010 and 43% in the third quarter of 2009. Non-GAAP wireless gross margin for the third quarter of 2010 was 46%, compared with 48% in the second quarter of 2010 and 43% in the third quarter of 2009.

Operating Expenses

For the third quarter of 2010, Sohu’s operating expenses totaled US$55.6 million. Non-GAAP operating expenses totaled US$50.1 million, down 1% sequentially from US$50.8 million and up 7% year-over-year.

Operating Margin

Operating margin was 40% for the third quarter of 2010, compared with 35% in the second quarter of 2010 and 39% in the third quarter of 2009. Non-GAAP operating margin was 44% for the third quarter of 2010, compared with 39% in the previous quarter and 42% in the third quarter of 2009.

Income Tax Expense

For the third quarter of 2010, excluding non-cash income tax expense of US$0.7 million recorded for tax benefits from share-based awards, non-GAAP income tax expense was US$10.6 million, compared with US$5.7 million in the previous quarter.

Net Income

Before deducting the share of net income pertaining to the Non-Controlling Interest, GAAP net income for the third quarter of 2010 was US$54.0 million, up 15% year-over-year and 19% quarter-over-quarter. Non-GAAP net income for the third quarter of 2010 was US$61.3 million, up 19% year-over-year and 17% quarter-over-quarter, exceeding Group guidance by US$4.8 million.

After deducting the share of net income pertaining to the Non-Controlling Interest, GAAP net income for the third quarter of 2010 was US$38.7 million, or US$1.01 per fully diluted share. Non-GAAP net income for the third quarter of 2010 was US$45.2 million, or US$1.16 per fully diluted share, an increase of 21% quarter-over-quarter, exceeding Group guidance.

Cash Balance

Sohu group continued to maintain a debt-free balance sheet and a strong cash position of US$534.7 million as of September 30, 2010.

Ms. Carol Yu, Co-President and CFO of Sohu, commented, “We achieved a strong third quarter with record revenues in each of our major business categories, and strong growth in our operations.  The strategic investment from Alibaba gives our search business a great opportunity to compete and capture market share.  The financing proceeds would fund the future development of Sogou business. And Sohu Group’s healthy operating cash flows, strong balance sheet, and growing platform point the way for us to further expand and deliver long-term value to our shareholders.”

Supplementary Information for Online Game Business

Operational Results

Aggregate registered accounts for Changyou’s games(2) as of September 30, 2010 increased 7% quarter-over-quarter and 40% year-over-year to 105.2 million.

Aggregate peak concurrent users (“PCU”) for Changyou’s games was approximately 980,000, a decrease of 14% quarter-over-quarter and an increase of 14% year-over-year.

Aggregate active paying accounts (“APA”) for Changyou’s games was approximately 2.61 million, a decrease of 6% quarter-over-quarter and an increase of 9% year-over-year.

ARPU for Changyou’s games increased 16% quarter-over-quarter and 13% year-over-year to RMB214, which is consistent with Changyou’s intention to have ARPU within a range that keeps Changyou’s games affordable for the majority of game players in China.

Revenues

Total revenues for the third quarter of 2010 increased 10% quarter-over-quarter and 25% year-over-year to US$85.6 million.

Revenues from game operations for the third quarter of 2010 increased 11% quarter-over-quarter and 25% year-over-year to US$83.6 million. The increases were mainly due to the continued popularity of TLBB, in China and higher spending from game players.

Overseas licensing revenues for the third quarter of 2010 decreased 7% quarter-over-quarter and increased 11% year-over-year to US$2.0 million. The sequential decrease was mainly the result of greater competition in mature online game markets abroad. The year-over-year increase was largely due to increased momentum of TLBB in Vietnam and Malaysia.

Recent Business Developments

Closing of Minority Strategic Investment in Sogou

On October 22, 2010, Sohu’s online search subsidiary Sogou Inc. completed the sale of newly-issued Series A Preferred Shares to Alibaba Investment Limited, a private investment subsidiary of Alibaba Group Holding Limited, China Web Search (HK) Limited, an investment vehicle of Yunfeng Fund, LP, and Photon Group Limited, the investment fund of Sohu’s Chairman and Chief Executive Officer Dr. Charles Zhang, for $15 million, $9 million, and $24 million, respectively, that represent approximately 10%, 6% and 16%, respectively, of the outstanding share capital of Sogou on a fully-diluted basis. Sohu and Sogou have established a share incentive program for Sogou management and key employees as well as certain members of Sohu’s executive management. Sohu will retain approximately 53% of Sogou on a fully-diluted basis, and intends in any event to retain a majority of the outstanding share capital of Sogou on a fully-diluted basis.

Open Beta Testing of Immortal Faith

On September 9, 2010, Changyou began open beta testing of Immortal Faith, Changyou’s first 2D mythical massively multi-player online role-playing game (“MMORPG”). Set against a backdrop of a number of ancient Chinese myths and folk tales, the game allows players to battle demons and assist deities in the conquest of various fairy kingdoms found in Chinese mythology. The game allows users to experience the life journey of becoming immortal by participating in the specially designed fighting modes and utilizing the game’s featured dynamic fighting moves.

Business Outlook

For the fourth quarter of 2010, Sohu estimates:

• Total revenues to be between US$163 million and US$168 million, with advertising revenues of US$64 million to US$66 million.
• Brand advertising revenues to be between US$58 million and US$60 million.
• Online game revenues to be between US$86 million and US$89 million.
• Non-GAAP net income before deducting the share of non-GAAP net income pertaining to the Non-Controlling Interest to be between US$59 million and US$61.5 million.
• Non-GAAP net income after deducting the share of non-GAAP net income pertaining to the Non-Controlling Interest to be between US$43 million and US$45 million
• Non-GAAP fully diluted earnings per share to be between US$1.10 and US$1.15.
• Compensation expense and income tax expense related to share-based awards, assuming no new grants of share-based awards, to be between US$7.5 million and US$8.5 million, which includes Changyou’s share-based compensation expense for the fourth quarter of 2010, which is expected to be between US$1.5 million and US$2.0 million. Considering Sohu’s share in Changyou, the estimated impact of this expense under US GAAP is expected to reduce Sohu’s fully diluted earnings per share for the fourth quarter of 2010 by 19 US cents to 22 US cents.

(1)  Explanation of the Group’s non-GAAP financial measures and related reconciliations to GAAP financial measures are included in the accompanying “Non-GAAP Disclosure” and the “Reconciliation to Unaudited Condensed Consolidated Statements of Operations.”

(2)  Comprises the following games operated in China: Tian Long Ba Bu (“TLBB”), Blade Online, Blade Hero 2, Da Hua Shui Hu, Zhong Hua Ying Xiong and Immortal Faith.

Non-GAAP Disclosure

To supplement the unaudited consolidated financial statements presented in accordance with United States Generally Accepted Accounting Principles (“GAAP”), Sohu’s management uses non-GAAP measures of cost of revenues, operating expenses, income tax expense, net income and net income per share, which are adjusted from results based on GAAP to exclude the impact of share-based awards granted to employees in the consolidated statements of operations, which consists mainly of share-based compensation expense and non-cash tax benefits from excess tax deductions related to share-based awards. These measures should be considered in addition to results prepared in accordance with GAAP, but should not be considered a substitute for, or superior to, GAAP results.

Sohu’s management believes excluding the impact of share-based awards from its non-GAAP financial measure is useful for itself and investors. Further, the impact of share-based awards cannot be anticipated by management and business line leaders and these expenses were not built into the annual budgets and quarterly forecasts, which have been the basis for information Sohu provides to analysts and investors as guidance for future operating performance. As the impact of share-based awards does not involve any upfront or subsequent cash outflow, Sohu does not factor this in when evaluating and approving expenditures or when determining the allocation of its resources to its business segments. As a result, in general, the monthly financial results for internal reporting and any performance measure for commissions and bonuses are based on non-GAAP financial measures that exclude the impact of share-based awards.

The non-GAAP financial measures are provided to enhance investors’ overall understanding of Sohu’s current financial performance and prospects for the future. A limitation of using non-GAAP cost of revenues, operating expenses, net income and net income per share, excluding the impact of share-based awards, is that the impact of share-based awards has been and will continue to be a significant recurring expense in Sohu’s business for the foreseeable future. In order to mitigate these limitations Sohu has provided specific information regarding the GAAP amounts excluded from each non-GAAP measure. The accompanying tables include details on the reconciliation between the GAAP financial measures that are most directly comparable to the non-GAAP financial measures that have been presented.

Notes to Financial Information

Financial information in this press release other than the information indicated as being non-GAAP is derived from Sohu’s unaudited interim financial statements prepared in accordance with GAAP.

Safe Harbor Statement

This announcement contains forward-looking statements. It is currently expected that the Business Outlook will not be updated until release of Sohu’s next quarterly earnings announcement; however, Sohu reserves right to update its Business Outlook at any time for any reason. Statements that are not historical facts, including statements about Sohu’s beliefs and expectations, are forward-looking statements. These statements are based on current plans, estimates and projections, and therefore you should not place undue reliance on them. Forward-looking statements involve inherent risks and uncertainties. We caution you that a number of important factors could cause actual results to differ materially from those contained in any forward-looking statement. Potential risks and uncertainties include, but are not limited to, the current global financial and credit markets crisis and its potential impact on the Chinese economy, the slower growth the Chinese economy experienced during the latter half of 2008 and in 2009, which could recur in the future, the uncertain regulatory landscape in the People’s Republic of China, fluctuations in Sohu’s quarterly operating results, and Sohu’s reliance on online advertising sales, online games and wireless services (most wireless revenues are collected from a few mobile network operators) for its revenues. Further information regarding these and other risks is included in Sohu’s annual report on Form 10-K for the year ended December 31, 2009, and other filings with the Securities and Exchange Commission.

Conference Call and Webcast

Sohu’s management team will host a conference call on October 25, 2010 (8:30 p.m. Beijing/Hong Kong time, October 25, 2010) at 8:30 a.m. U.S. Eastern Time.

The live webcast and archive of the conference call will be available on the Investor Relations section of Sohu’s website at http://corp.sohu.com/.

About Sohu.com

Sohu.com Inc. (Nasdaq: SOHU) is China’s premier online brand and indispensable to the daily life of millions of Chinese, providing a network of web properties and community based/web 2.0 products which offer the vast Sohu user community a broad array of choices regarding information, entertainment and communication. Sohu has built one of the most comprehensive matrices of Chinese language web properties and proprietary search engines, consisting of the mass portal and leading online media destination www.sohu.com; interactive search engine www.sogou.com; #1 games information portal www.17173.com; the top real estate website www.focus.cn; #1 online alumni club www.chinaren.com; wireless value-added services provider www.goodfeel.com.cn; leading online mapping service provider www.go2map.com; and developer and operator of online games www.changyou.com.

Sohu corporate services consist of brand advertising on its matrix of websites as well as paid listing and bid listing on its in-house developed search directory and engine. Sohu also offers wireless value-added services such as news, information, music, ringtone and picture content sent over mobile phones. The Company’s massively multiplayer online role-playing game (MMORPG) subsidiary, Changyou.com (Nasdaq: CYOU), currently operates six online games, including Tian Long Ba Bu, one of the most popular online games in China, and the licensed Blade Online, Blade Hero 2, Da Hua Shui Hu, Zhong Hua Ying Xiong and Immortal Faith. Sohu.com, established by Dr. Charles Zhang, one of China’s internet pioneers, is in its fourteenth year of operation.